I have an medical office with 2 providers. We are set up as an S-corp with 50/50 shareholding in Texas. However, we see our own patients. Initially, one provider paid in more for start-up. However, over the short time we have been open, the other provider has earned about $23K more. We did not have any written agreement (I know, bad idea) on pay back, but agreed that the one that put in less would paid back the other. We agreed to have one bank acct in the beginning to make it easy, since we knew it would take time to build up clients. (we are a chiropractic cash practice). We see our own patients, and have it set up in our software to designate provider. As business increased, we agreed to get our own accts, and pay into the main acct 50% expenses. (we haven't done this yet)
Now, my question is: when we split the accts, do we calculate amount of start up capital for each person and consider the retained earnings of each to satisfy debt? or.... do we calculate start up capital for each and call the difference in earnings a wash? Again, we don't have a written agreement. We do both agree that our patients are our patients and that the money earned by us is ours. We have not yet been paid since opening--all money earned has been used to run clinic, buy supplies, pay rent, continuing ed, and additional certifications for both docs.

If we use separate accts, do we need to change the business structure?
What type of corp entity would satifsy office sharing?

We do both agree that our patients are our patients and that the money earned by us is ours.

Lets review some facts:

1. An S-corp is owned by the shareholders holding shares of stock. In your case this is 2 individuals both holding the same number of stock certificates.

2. Year-end Profits/losses after salary expense are allocated on a "per share basis" (50-50 in your case) and reported for taxation on the shareholders 1040. No exception.

3. The only way shareholders/officers can take money out of the S-corp is by employee W2 type payroll salary or distributions of profits by way of cash or tangible property. (Exception would be reimbursements for expenses paid by the individual or something such as rent of equipment.) Distributions of profit are not taxable since the profit is taxable under item #2.

4. Active shareholders/officers of the S-corp MUST take a reasonable payroll W2 type salary. If there are no profits to take such salary then there is no salary required unless such shareholders have taken money out of the corporation in the form of distributions.

5. Retained earnings is profit/loss that has not been distributed to shareholders but shareholder have already or will pay the taxes on their form 1040.

Therefore, for each doctor to get his fair share of earnings according to your agreement, the doctor must do so by unequal W2 payroll salary so that the left over earnings is equal 50-50 and may then be distributed equally per share.

As Oldjack said, if what you want to accomplish is reflecting the different patient revenues, you can do that through adjusting the salaries. That is relatively common among professional practices. You do not need to change your structure.

If you want to reflect the different capital contributions, you have to be much more careful. S corporations must have a single class of stock. It is very easy to get tripped up by treating one shareholder's 50% differently than the other shareholder's 50%. If you are deemed to have a second class of stock, your S election is terminated and you revert to a C corporation. That is one reason why, in many cases, an LLC may make more sense than an S corporation.

One shareholder in an S corporation CANNOT get a preferred return ON or OF his equity. In your current structure, if one shareholder is going to get back money that he fronted to the corporation, it is important that the money be put in as debt rather than as equity. If the money is already in the business as equity, it may be possible to adjust the salary formula to indirectly reflect the contribution, but it gets much more questionable and there are different tax consequences.

If A made $100 and B made $120, each reports $60K as income on their 1040. That $60,000 is not yours. It's the corporations. You just elected that you didn't wanted it taxed as a separate entity (which is probably smart because you'd be taxed at 35%.) If this situation was as basic as this, the company would have $220K in Retained Earnings. These retained earnings are used to grow the business, and can also be distributed to shareholders on an EQUAL basis. If we each own 1 share and a $1 dividend is declared, you don't get $2 because you're writing the checks.

Whether it is debt or equity depends on how you recorded it and how it was understood the initial money fronted was. If it was accepted under the terms that the business would pay this back to him, plus interest, then it is a loan. If not, it's presumably equity. Of course the situation isn't as easy as that. But with loans, the business should be accruing interest on these before it pays it back.

Evan,
First, there is no written agreement. One person paid 20K for build out, with verbal agreement that half would be paid back at later time.

Next, we agreed that income earned by each would we ours.

CPA said s-corp was best set up for us to avoid double taxation. He assured us that our earnings would be distributed according to what each earned ( my patients mine, money from them is mine, same for partner). However, this isn't in writing anywhere. S-corp set up with 50/50 shareholding. We owe all equipment outright before startup 50/50.
So, accting software is designed to show who sees whom and earns what. We agreed to leave all earnings in acct until later date for ease.
We agreed we would split accts later and determine who made what when we were making more.
Now, after a period of time, one has earned a substantial amount more. Not a big deal if the accounts had been seperate, but.........now, a big deal because accts were combined.

Minus any written agreement, is half of 20K still owed?
It isn't put in as a debt or capital yet. We are disputing that now.

I understand now that income is 50/50 split for an s-corp set up this way. However, we specifically told our CPA we wanted our income distributed according to what each produced individually.

I see the contribution to the company to be equal: 20K intial capital by A (buildout), 20K retained earnings by B, thus cancelling out any debt. I would have never agreed to a combined acct., otherwise.

If this ends up going to mediation or atty, without written agreements, what is the probable outcome?
Next question, what biz structure would be suitable for us? (sharing office space, expenses)

>>He assured us that our earnings would be distributed according to what each earned ( my patients mine, money from them is mine, same for partner). However, this isn't in writing anywhere. S-corp set up with 50/50 shareholding. We owe all equipment outright before startup 50/50.<<

GET YOURSELF A NEW CPA AS IF THIS IS REALLY A CPA HE IS STUPID TO MAKE SUCH A STATEMENT that would obviously terminate the S-corp status. Maybe you just misunderstood him.

To begin with your individual that contributed zero for his stock has zero shares of stock as shares of stock has to be paid for or the receiver has to acknowledge taxable income (at the Fair Market Value of the stock) as W2 wages for the same (sweat equity). Of course if the corporation has booked a receivable for his 50% of the outstanding shares then he could be issued the shares of stock but he must pay off the receivable in a reasonable amount of time.

Second, have you actually issued shares of stock? Distributions can only be made to issued shares of stock on a per share basis...period.

It almost sounds like you want to operate like a partnership and split things as though you were a self-employed business.

Just to clarify it is a fact that retained earnings is owned equally by each outstanding share of stock issued and not by who generated the income or owns the client. If you don't hold issued shares of stock you don't own or have a right to diddle squat.

If your dispute over that $20K ended up in court (or arbitration), it's whomever story is more believable. It is not uncommon though for one person to contribute more than the other and the ownership be "equal".

An S-Corp is probably the best entity for you. Not only for the reason of double taxation, but also being a professional. If you were a C-Corp, you'd be taxed at 35% regardless of profits, which is not really desirable. Unfortunately, you may have misunderstood about earnings being distributed based on what you earned. In order to do that, you need to take a salary, which is the only thing that does not need to be equal. Jack pointed that out above. So if you had (for example) $30,000 to distribute to each other, it must be equal if you have 50/50 ownership.

You can continue to operate under this single S-Corp. As long as your income is split, you can find what your annual expenses are for the year and divide by two. Of course, your expenses really aren't 50/50. If he's producing more income, his share of expenses is probably higher. Perhaps figure out your percentage of total income versus his percentage, and use that same number time expenses. (So if 40% of income comes from you, 40% of expenses are shared by you.) This just requires good accounting.

Is he arguing over the $10K that he owes you? If not, $20K in retained earnings would equal out (this year) the initial capital contribution assuming you both took equal salaries so he'd have extra in the company. The problem becomes next year if you experience a loss (for example). Retained earnings fluctuates based on income, but your paid in capital is what you've put into the business.

Lesson learned: get everything in writing. You'll agree on everything. Until you disagree.